If you’re making regular contributions to an employer-sponsored retirement plan, such as a 401(k) or 403(b), congratulations! You’re taking steps toward a more secure financial future. However, even those who participate in a 401(k) plan may worry they’re not contributing enough to achieve their retirement goals.
Unfortunately, as with so many financial planning challenges, there’s no single guideline to ensure you’re putting enough aside. Even if you have an idea of the dollar amount you’ll need to comfortably retire, the amount you need to save varies based on a wide range of factors, including when you start investing, your portfolio allocation, market events, lifestyle goals, spending habits, inflation, etc.
A general rule of thumb is to invest 15 percent of your income in a retirement account, but your exact savings requirements may differ widely from that number. Rather than focusing on a specific percentage, consider implementing the following tips to help maximize your employer-sponsored retirement plan benefits.
1. Start contributing early.
Thanks to the power of compound interest, it’s typically more advantageous to start contributing to a 401(k) as early as possible, even if you’re only able to commit to a small amount.
2. Maximize your employer match.
If someone offered to give you $3,000 each year with no strings attached, would you take it? Of course you would! Yet many people pass up retirement savings opportunities by not contributing enough to their 401(k) to receive the full value of their employer’s matching contribution. That’s essentially saying no to “free” money.
3. Increase your contributions by 1 to 2 percent each year.
Once you’re contributing enough to receive your full employer match, consider increasing your contributions each year or whenever you receive a raise. Even a 1 to 2 percent annual increase can have a big impact on your savings over time, and you’re unlikely to even notice the impact on your take-home pay.
4. Diversify your contribution types.
Many employer-sponsored retirement plans offer the option of contributing to a traditional (pre-tax) 401(k) or a Roth (after-tax) 401(k).
• Traditional 401(k) contributions provide the benefit of lowering your taxable income during the year in which they’re made. However, these assets and their earnings are taxed as ordinary income when you withdraw them in retirement.
Once you are retired and reach a certain age, the IRS requires you begin taking required minimum distributions (RMDs) from your pre-tax retirement accounts. These withdrawals are subject to ordinary income tax.
• Roth 401(k) contributions don’t provide an immediate tax benefit, but assets can be withdrawn without federal income tax as long as you’ve reached age 59.5 and held the account for at least five years.
In addition, Roth 401(k) contributions aren’t subject to RMDs, which means your assets can continue growing within the account throughout retirement.
Contributing a portion of your retirement savings to both types of accounts offers a combination of tax benefits, including:
• An opportunity to lower your current taxable income when you’re in a high tax bracket by making pre-tax contributions
• Flexibility and tax-planning opportunities in retirement that allow you to draw from accounts with different tax treatments, based on your changing needs, market conditions, and tax exposure.
Gene Gard, CFA, CFP, CFT-I, is a Partner and Private Wealth Manager with Creative Planning. Creative Planning is one of the nation’s largest Registered Investment Advisory firms providing comprehensive wealth management services to ensure all elements of a client’s financial life are working together. For more information or to request a free, no-obligation consultation, visit CreativePlanning.com.
